Hedge Funds Are Suing to Freeze Puerto Rico's Government Bank

Creditors of Puerto Rico’s Government Development Bank on Monday sued to stop it from distributing money to creditors in what they call “preferential transfers” ahead of the GDB’s May 1 debt payment that Puerto Rico’s governor says may not be payable.

Hedge funds including Brigade Capital Management and Claren Road Asset Management, which hold some of GDB’s $3.75 billion in debt, asked a federal court in San Juan, Puerto Rico, to bar municipalities, public entities and other depositors from removing their money, to prevent a run on the bank.

The lawsuit is the latest sign of an increasingly urgent financial crisis in Puerto Rico, which has $70 billion in total debt, a 45% poverty rate and a shrinking population.

Both houses of the legislature planned to work late to vote on a bill that would let Puerto Rico’s governor declare a debt moratorium, and change elements of the GDB’s charter law, the governor’s Chief of Staff Grace Santana, Senate President Eduardo Bhatia and House Speaker Jaime Perello told reporters.

The GDB owes nearly $4 billion, including a $422 million payment on May 1, which Puerto Rico Governor Alejandro Garcia Padilla has said it cannot pay. The island, as a whole, faces a July 1 payment of $1.55 billion on various debt classes.

The GDB and its creditors are in the midst of restructuring talks that could lead to a forbearance agreement or debt restructuring. Monday’s lawsuit was filed to give those talks time to evolve without a fear of a run on the bank, said Donald Bernstein, a lawyer for the creditors.

“GDB needs to be able to fund essential services, but to the extent money is being pulled out by people who want to bail out of the situation at the expense of other creditors, that shouldn’t happen,” Bernstein said in an interview.

GDB acts as the commonwealth’s main liquidity source, with public agencies drawing on accounts to fund services and pay their own debt.

GDP President Melba Acosta Febo said the central claim of the lawsuit, that the bank withheld financial information in order to prefer certain depositors over its bondholders, is false and not based in fact.

“Although the specific allegations set forth in the lawsuit are erroneous, it is clear that our creditors agree with us on one thing: Puerto Rico’s fiscal situation is dismal, the Island’s debt is unpayable, and the need for a federal restructuring regime to help the Commonwealth on the road to recovery is acute,” Acosta said in a statement.

A default at the GDB could allow creditors to seek the appointment of a receiver, a process that would be triggered by Puerto Rico’s treasury secretary, Juan Zaragoza.

Zaragoza last week resigned his membership on GDB’s board of directors, which a source close to the restructuring talks at GDB told Reuters was done to avoid a conflict of interest in the event he must appoint a receiver.

The same source said the island’s treasury department is not considering removing money from GDB, but is considering opening new accounts at other banks in the event GDB becomes insolvent.

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